Opinion
CIVIL ACTION No. 00-2109-KHV.
January 8, 2001.
MEMORANDUM AND ORDER
Plaintiff Cynthia Grimes filed suit on behalf of Stoico Restaurant Group, Inc. ("SRG") alleging that defendants breached their fiduciary duties as directors and officers of SRG. This matter comes before the Court on Defendant James Ash's Motion To Dismiss Plaintiff's Amended Complaint (Doc. #27) and Defendants Martsolf and Jeffrey's Motion To Dismiss Count 1 Of Plaintiff's First Amended Complaint (Doc. #29), both filed August 24, 2000. For reasons stated below, the Court finds that each motion should be overruled.
Motion to Dismiss Standards
In ruling on a motion to dismiss under Fed.R.Civ.P. 12(b)(6), the Court must assume as true all well pleaded facts in plaintiff's complaint and view them in a light most favorable to plaintiff. Zinermon v. Burch, 494 U.S. 113, 118 (1990). The Court must make all reasonable inferences in favor of plaintiff, and liberally construe the pleadings. See Fed.R.Civ.P. 8(a); Lafoy v. HMO, 988 F.2d 97, 98 (10th Cir. 1993). The issue in reviewing the sufficiency of the complaint is not whether plaintiff will prevail, but whether she is entitled to offer evidence to support her claims. See Scheuer v. Rhodes, 416 U.S. 232, 236 (1974).
The Court may not dismiss a cause of action for failure to state a claim unless it appears beyond a doubt that plaintiff can prove no set of facts in support of her theories of recovery that would entitle her to relief. See Jacobs, Visconsi Jacobs, Co. v. City of Lawrence, 927 F.2d 1111, 1115 (10th Cir. 1991). Although plaintiff need not precisely state each element of her claims, plaintiff must plead minimal factual allegations on material elements that must be proved. See Hall v. Bellmon, 935 F.2d 1106, 1110 (10th Cir. 1991).
Factual Background
The allegations in plaintiff's amended complaint may be summarized as follows: SRG is a Delaware corporation with corporate headquarters formerly located in Wichita, Kansas. From 1996 to 1998, Tim Jeffrey, Cathy Martsolf and James Ash were shareholders of SRG and officers on its board of directors. Ash was also securities counsel for SRG.
In 1996, Jeffrey, Martsolf and Ash participated in an initial public offering of SRG stock ("the IPO"). As directors, they had primary responsibility for choosing underwriters and preparing a prospectus for potential investors. The prospectus consisted of a business plan to open ten to 12 restaurants, requiring capital expenditures of $2.9 million in 1996 and $4.7 million in 1997. In mid-1996, defendants were warned that an IPO at a market capitalization value of less than $50 million was questionable and that the proposed underwriter, Primeline Securities Corporation, lacked experience and recognition in the field. Before the IPO closed in December 1996, it became apparent or should have become apparent to SRG directors that the public financing revenue would be inadequate to fully fund and operate the restaurants according to the business plan.
In December 1996, defendants disseminated false and misleading information to potential investors with respect to the marketability of the stock, the identity of the management company, the availability of IPO proceeds to fund construction of new restaurants, and the identity of the person who would become the majority shareholder of SRG. Because of the deficit created by the unsuccessful IPO, SRG began borrowing hundreds of thousands of dollars in connection with the construction and outfitting of new restaurants. SRG records do not indicate that defendants disclosed to the rest of the board the funding shortages, the sales representations, the securities law implications of the shortages or the majority change in ownership.
By November or December 1996, defendants knew or should have known that Jeffrey had asked a creditor of SRG to convert 85% of a $4.75 million loan to stock in the IPO. In doing so, Jeffrey showed the creditor a budget that was not part of the prospectus and promised it a seat on the board of directors. The creditor agreed and as a result of the debt conversion, the IPO was able to close. Informed, disinterested board members, however, did not approve the decisions to close the IPO and proceed with the restaurant expansion program without adequate funds.
Martsolf and Jeffrey had conflicts of interest with SRG because they paid themselves salaries, stock options and other forms of compensation which exceeded the financial abilities of the corporation. Their employment and compensation were in jeopardy if the IPO did not close. Moreover, Jeffrey had taken "advances" that he would have to immediately repay if the IPO did not close. Ash also had a conflict of interest, in that he and his law firm expected to receive thousands of dollars for legal work related to the IPO.
In March 1997, Martsolf and Ash disseminated a letter to SRG shareholders which stated that the IPO had raised enough capital to fund the expansion program. The IPO did not raise sufficient capital, however, and without the knowledge or approval of other board members, Ash and Martsolf obtained loans to pay for restaurant construction. By June 1997, SRG had to close six newly-opened restaurants because it lacked the capital necessary to operate them. In August, investors who had purchased stock in the IPO filed a class action suit against SRG, Jeffrey and Louie Stoico for securities law violations and misfeasance. Michael Thompson, a law partner of James Ash, represented defendants in the class action, which settled out of court. On March 6, 1998, SRG sought bankruptcy protection under Chapter 11 and the bankruptcy court appointed Grimes to represent the corporation with specified powers of a trustee.
Grimes filed the present suit against the former officers and directors of SRG, seeking damages for breach of fiduciary duties to the company and its other shareholders. The Court previously dismissed plaintiff's complaint with leave to amend because plaintiff did not expressly plead facts which were sufficient to overcome the presumption of the business judgment rule and she did not adequately plead causation. See Memorandum and Order (Doc. #24) filed July 20, 2000. On August 7, 2000, plaintiff filed her amended complaint. Jeffrey, Martsolf and Ash filed motions to dismiss, arguing that plaintiff has again failed to allege facts which rebut the presumption of the business judgment rule, e.g. bad faith and fraudulent intent. Defendants also argue that plaintiff has failed to adequately plead causation.
Analysis
Defendants' motions to dismiss will be considered jointly as they present nearly identical arguments regarding the sufficiency of plaintiff's amended complaint. Once again, the parties do not address what state law governs the suit. As explained before, the Court discerns no material difference between the applicable substantive law in Kansas and Delaware and accordingly, it need not resolve the choice of law issue at this time. See Memorandum And Order (Doc. #24) filed July 20, 2000 at 3.
Plaintiff alleges that defendants breached their fiduciary duties to SRG by failing to inform shareholders about financial decisions, disseminating misleading information to potential investors, failing to obtain board approval to ask a creditor to transfer SRG's debt to stock, and failing to disclose material matters in the Prospectus. Plaintiff also alleges that "other matters alleged in this complaint constitute fraud on SRG and bad faith and self dealing with respect to pursuit of the closing of the IPO." First Amended Complaint (Doc. #26) filed August 7, 2000 ¶ 26.
"The business judgment rule normally protects all lawful actions of a board of directors, provided they were taken in good faith, after a reasonable deliberative process and in the absence of conflicts of interest." Kahn v. Roberts, 679 A.2d 460, 465 (Del. 1996). Defendants argue that plaintiff has not alleged facts which are sufficient to overcome the presumption of the business judgment rule. Plaintiff correctly notes, however, that an allegation of a conflict of interest by one of the board members is sufficient. See Aronson v. Lewis, 473 A.2d 805, 812 (Del.Super.Ct. 1984). If a conflicting directorial interest exists, the business judgment rule does not apply unless the questioned transaction is approved by a majority of disinterested directors. See id.; Del. C. Ann. title 8, § 144(a)1 (2000). Conflicting directorial interest exists whenever a director is a party on both sides of a transaction or expects to receive a material personal financial benefit from the transaction as opposed to a financial advantage that would benefit all stockholders generally. See Cede Co. v. Technicolor, Inc., 634 A.2d 345, 363-64 (Del. 1993); Aronson, 473 A.2d at 812.
In her original complaint, plaintiff included only conclusory allegations of bad faith and misfeasance. In her amended complaint, however, plaintiff has set forth specifically how each defendant stood to receive a material financial benefit that would not be enjoyed by shareholders generally. First, plaintiff avers that Martsolf and Jeffrey took forms of compensation in excess of the financial capabilities of SRG and that their employment and compensation were in jeopardy if the IPO did not close. In addition, plaintiff alleges that "Jeffrey had taken advances from the company that he would be called upon more immediately to repay if the IPO were not closed." First Amended Complaint (Doc. #26) ¶ 24. Plaintiff also claims that Ash, as securities and corporate legal counsel, had a conflict of interest because he "expected to bill thousands of dollars for legal work relating to the IPO." Id. ¶ 25. Based on these allegations, a reasonable trier of fact could conclude that Martsolf, Jeffrey and Ash stood to receive a material financial benefit from closing the IPO that would not be enjoyed by the shareholders generally. See, e.g., Cede, 634 A.2d at 363 (entrenchment motive or abdication of directorial duty may be sufficient evidence of disloyalty to rebut presumption of business judgment rule).
Based on the alleged conflicts of interest by Martsolf, Jeffrey and Ash, the business judgment rule does not apply unless the questioned transaction was approved by a majority of disinterested board members. See Aronson, 473 A.2d at 812. Plaintiff alleges that the decisions to close the IPO and to proceed with the restaurant expansion program without adequate funds were not approved by informed, disinterested board members. See First Amended Complaint ¶¶ 26, 38. Assuming that this allegation is true, the business judgment rule does not protect the board's actions from judicial scrutiny.
Defendants also contend that plaintiff has not adequately pled the element of causation in her claim for breach of fiduciary duty. The Court disagrees. In her amended complaint, plaintiff asserts that because defendants closed the IPO early, proceeded with the expansion program when SRG was short of funds, and took part in other conduct outlined in the complaint, the restaurant expansion program failed, SRG incurred millions of dollars in debts, and SRG incurred a significant liability associated with the class action suit. See id. ¶ 40. These allegations are sufficient to establish "but for" causation. Defendants' motions to dismiss are therefore denied.
IT IS THEREFORE ORDERED that Defendant James Ash's Motion To Dismiss Plaintiff's Amended Complaint (Doc. #27) filed August 24, 2000 and Defendants Martsolf And Jeffrey's Motion To Dismiss Count 1 Of Plaintiff's First Amended Complaint (Doc. #29) filed August 24, 2000 be and hereby are OVERRULED.